This week has been a tough one for stocks, with the S&P 500 falling 5% over the last week, the Dow dropping nearly 7%, and the Nasdaq slipping 4.5%.
Looking at the S&P 500’s chart, it appears the index has formed a bearish double top wherein the price hits two consecutive highs with a moderate decline between the two peaks. If the price then falls below that low, the double top is confirmed.
The S&P 500 notched a record high of $3,580.84 on September 2, then swung to a low of $3,236.92 on September 23 before rising to a second high of $3,534.22 on October 12. The index has since fallen 7% since that second high and ended Thursday just 1% above the September intermediate low.
The top is in for the market, Greenlight Capital founder David Einhorn warned in a letter this week, after an “enormous” bubble in technology stocks popped last month.
Einhorn said that Greenlight had “prematurely identified” a bubble in tech in a warning it issued in 2016. Back then, the firm said that the height of the 1999 – 2000 dotcom bubble was a once-in-a-career experience and that investors wouldn’t repeat “that level of insanity” again.
“Clearly, we were mistaken,” Einhorn said, as stocks have since risen to nosebleed valuations.
Tech stocks have driven the market’s record rally this year, with the Nasdaq 100 up 59% since the market bottom on March 23 led by gains in Zoom Video Communications (NASDAQ: ZM)—which is up more than 223% in the same timeframe—and Tesla (NASDAQ: TSLA), which has gained 367% since the market bottom. The S&P 500, by comparison, is up 46% since its March 23 low.
Einhorn wrote that bubbles tend to pop under their own weight as investors finally hop in, short sellers cover, and the “last buyer has bought (or bought massive amounts of weekly calls).”
“The decline starts and the psychology shifts from greed to complacency to worry to panic,” Einhorn added.
The billionaire investing legend then pointed to several signals that back up his bubble call, the recent mania around IPOs, extraordinary valuations and new metrics for valuations, a huge concentration in one sector (tech) and a small handful of stocks, a second-tier of stocks that investors haven’t heard of that have risen to S&P 500-level market capitalizations, the outperformance of companies suspected of fraud based on the consensus belief that there is no risk of enforcement, outsized reaction to economically irrelevant stock splits, the growing participate of retail investors in the market who pile into the best-performing names, wild trading volumes in speculative trades, and a parabolic rise toward the market top.
“The question at hand is where are we in the psychology of this bubble?” Einhorn said. “Our working hypothesis, which might be disproven, is that September 2, 2020 was the top and the bubble has already popped. If so, investor sentiment is in the process of shifting from greed to complacency.”
As a result, Einhorn said that Greenlight has adjusted its portfolio of companies its wagering against.
“We have adjusted our short book accordingly including adding a fresh bubble basket of mostly second-tier companies and recent IPOs trading at remarkable valuations,” Einhorn added.
Beyond its short wagers, the fund also started “medium-sized” long positions in names including information technology company Synnex (NYSE: SNX), Austrian sensor maker AMS AG (OTC: AMSSY), and ATM-manufacturer NCR Corp (NYSE: NCR).